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Referrals in Search Markets

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  • Maria Arbatskaya
  • Hideo Konishi

Abstract

This paper compares equilibrium outcomes in search markets with and without referrals. Although consumers would benefit from honest referrals, it is not at all clear whether firms would unilaterally provide information about competing offers since such information could encourage a consumer to purchase the product elsewhere. In a model of a horizontally differentiated product and sequential consumer search, we show that valuable referrals can arise as a part of equilibrium: firm will give referrals to consumers whose ideal product is sufficiently far from the firm;s offering. The effect of referrals on the equilibrium prices is examined, and it is found that prices are higher in markets with referrals. Although consumers can be made worse off by the existence of referrals, referrals lead to a Pareto improvement as long as search cost is not too low relative to product heterogeneity. The effects of referral fees and third-party referrals are examined and policy implications are drawn.

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Paper provided by Department of Economics, Emory University (Atlanta) in its series Emory Economics with number 0521.

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Date of creation: Jul 2005
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Handle: RePEc:emo:wp2003:0521

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  1. Simon P. Anderson & Regis Renault, 1997. "Consumer Information and Firm Pricing: Negative Externalities from Improved Information," Virginia Economics Online Papers 338, University of Virginia, Department of Economics.
  2. Birger Wernerfelt, 1994. "Selling Formats for Search Goods," Marketing Science, INFORMS, vol. 13(3), pages 298-309.
  3. Wolinsky, Asher, 1986. "True Monopolistic Competition as a Result of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 101(3), pages 493-511, August.
  4. Konishi, Hideo, 2005. "Concentration of competing retail stores," Journal of Urban Economics, Elsevier, vol. 58(3), pages 488-512, November.
  5. Wolinsky, Asher, 1984. "Product Differentiation with Imperfect Information," Review of Economic Studies, Wiley Blackwell, vol. 51(1), pages 53-61, January.
  6. Asher Wolinsky, 1983. "Retail Trade Concentration Due to Consumers' Imperfect Information," Bell Journal of Economics, The RAND Corporation, vol. 14(1), pages 275-282, Spring.
  7. Mark V. Pauly, 1979. "The Ethics and Economics of Kickbacks and Fee Splitting," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 344-352, Spring.
  8. Stephen J. Spurr, 1990. "The Impact of Advertising and Other Factors on Referral Practices, with Special Reference to Lawyers," RAND Journal of Economics, The RAND Corporation, vol. 21(2), pages 235-246, Summer.
  9. Diamond, Peter A., 1971. "A model of price adjustment," Journal of Economic Theory, Elsevier, vol. 3(2), pages 156-168, June.
  10. Janssen, Maarten C.W. & Moraga-Gonzalez, Jose Luis & Wildenbeest, Matthijs R., 2005. "Truly costly sequential search and oligopolistic pricing," International Journal of Industrial Organization, Elsevier, vol. 23(5-6), pages 451-466, June.
  11. Stiglitz, J E, 1979. "Equilibrium in Product Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 69(2), pages 339-45, May.
  12. Colwell, Peter F & Kahn, Charles M, 2001. "The Economic Functions of Referrals and Referral Fees," The Journal of Real Estate Finance and Economics, Springer, vol. 23(3), pages 267-96, November.
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Cited by:
  1. Ding, Ke & Gokan, Toshitaka & Zhu, Xiwei, 2013. "Search, matching, and self-organization of a marketplace," IDE Discussion Papers 396, Institute of Developing Economies, Japan External Trade Organization(JETRO).

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